Public debt and inflation dynamics in South Africa: An estimated NK-DSGE model with a monetary and fiscal policy mix regime

Working Paper 934

Abstract

This study estimates a closed economy NK-DSGE model with a monetary and fiscal policy mix regime to examine the role of a coexistence regime in shaping the effects of policy shocks on the dynamics of public debt, inflation, and other key variables in South Africa. The results show that when the monetary and fiscal authorities coordinate to stabilize public debt, as in the coexistence regime, the macroeconomic effects of fiscal and monetary policy shocks are relatively balanced. The coexistence regime emerges as a more desirable policy mix, offering a solution to stable economic growth while effectively managing both public debt and inflation, compared to Regime M (an active monetary policy and a passive fiscal policy) and Regime F (an active fiscal policy and a passive monetary policy). While supply and demand shocks remain important drivers of fluctuations in public debt and inflation, the contribution of policy shocks is also non-negligible. Both the debt service cost channel and the initial fiscal condition play a significant role in shaping the dynamics of public debt and inflation.